Performance-based ratemaking (PBR) departs from the cost-of-service standard in setting just and reasonable utility rates, but that departure isn't as easy as it looks.
Up until now, cost-of-...
While the prices play catch up, utilities and regulators should start looking for ways to mitigate costs.
Water utility rate increases have outpaced those of other utilities. In fact, water rate increases since 1984 %n1%n have surpassed the overall rate of inflation. Yet among utility services, water remains a real bargain; consumers spend less on water than on any other utility.
While more stringent drinking water standards, an aging infrastructure and increasing demand have all contributed to these recent increases, rising water utility costs also stem from historic underpricing. Pricing water services at artificially low prices has harmed consumers. If water services were priced correctly, consumers would benefit through improved system maintenance and water quality, timely replacement of aging capital facilities and more reliable service. In the long term, rising prices will induce conservation and more efficient water use. New facilities will be sized more appropriately to meet demand patterns that reflect realistic prices.
In recent years, state public utility regulators have proven more willing to price water correctly. But inflationary prices also can affect how industries are regulated.
Policymakers tend to increase regulatory control when costs are increasing, and decrease control when costs are falling. %n2%n Stable or falling energy and telecommunications prices and increasing competition provide an opportunity to relax price regulation or even to deregulate. But rising costs would argue for continued regulatory oversight of the water sector, if not closer scrutiny of utilities.
Utility Spending and Historical Underpricing
Prices for electricity, natural gas and general and interstate telephone service have increased well below overall inflation rates (see Figure 1). Local telephone service prices have risen close to rates indicated by the overall Consumer Price Index. Price increases for refuse collection, cable television and water and sewer services substantially exceed the CPI. Refuse collection prices could be affected by a move toward more efficient pricing and increasing disposal costs due to limited availability and environmental regulations. Cable television prices could reflect the lack of regulatory oversight for a monopolistic service. However, cable service also has available substitutes and is less essential (although some cable fans might disagree).
Based on the 1994-1995 Consumer Expenditure Survey by the Bureau of Labor Statistics, the average four-person household spent $2,727 on utilities, which is 6 percent of total annual household expenditures (see Figure 2). This figure included $1,104 for electricity, $334 for natural gas, $105 for fuel oil and other fuels, $842 for telephone and $342 for "water and other public services" (including wastewater and solid waste charges). Water and other public services accounted only for 13 percent of annual household utility expenditures and 0.8 percent of total annual household expenditures. Real water prices, however, are beginning to move higher.
Why are real water prices on the rise? Several reasons can be proposed, but the standard trilogy is: 1) compliance with federal and state drinking water standards; 2) rehabilitation and maintenance of an aging water delivery infrastructure; and 3) meeting demand growth.
While the Safe Drinking Water Act is cited as a source of increasing costs, federal and state drinking water regulations are